Australia's NAB Sept quarter business confidence index falls to 2

National Australia Bank Ltd (NAB) said its business confidence index, which measures expectations for the following quarter, fell to two points in the three months to September from 8 in the June quarter. The index is seasonally adjusted. NAB said overall business conditions, a composite of trading conditions, profitability and employment across the non-farm business sector, were unchanged at 12 points from the June quarter. It said the components of trading conditions and profits rose slightly in the September quarter, but were offset by a weaker employment component. NAB chief economist Alan Oster said the core message from the latest quarterly survey is that the two 25 basis point rate increases by the Reserve Bank of Australia in May and August have significantly eroded confidence. He said this was evident in a fall in the forward orders component of around three points. Oster said while business conditions are still at reasonable levels, near term and longer term expectations again point to a slowing but nothing that is of an alarming nature. "While the survey suggests that the domestic demand is at or has recently reached a turning point, it still bears noting that the overall performance is still relatively strong," he said. However, Oster said the economy continues to operate at very high levels of capacity utilization with the September quarter reading of 83.3 pct the highest on record. "This clearly reflects the impact of 16 years of continuous growth. In such an environment, it is also not surprising that employers continue to report great difficulty in obtaining suitable labor which in turn has seen unemployment fall to 30 year lows," he said. The chief economist said that while the overall economy is travelling reasonably well, the differences across regions and industries are marked which are in turn making monetary policy judgments more difficult. Oster said by industry the strength of mining, infrastructure and non-residential construction comes as no surprise, and business services also seems to have strengthened in the September quarter. "It also comes as little surprise that the cyclical sectors, such as retail (especially cars), wholesale and manufacturing continue to report the weakest overall levels of business activity," he said. On a regional basis, Oster said his firm's latest quarterly survey continued to show the vast differences between strong growth in the resource exporting states of Western Australia and Queensland, while the larger Eastern economies of New South Wales and Victoria lag well behind. "The trends in conditions in NSW and Victoria are hardly encouraging. In brief, it highlights the significant economic risks that an overly aggressive RBA could pose to the largest states in 2007," Oster said. In addition, Oster said the falling business confidence is weighing on business investment decisions. "The survey results suggest that we have entered a phase of little further growth in on going investment, and probably negative outside of mining. Again, this points to a major reason why the RBA should be careful," he said. Oster said a further concern for the RBA is that while wage pressures are contained for the moment, it will need to remain very watchful in this area given the still very tight labor market and capacity utilization at record levels. Meanwhile, Oster said with his firm's outlook of the global economy peaking in 2006, they expect the Australian economy to grow by 2.5 pct over the year to June 2007, improving slightly to 3.0 pct in calendar 2007 and, on early estimates, rising to 3.25 pct in 2008. He said domestic demand, having slowed to 3.75 pct over the year to June 2006, is expected to slow further to 2.5 pct in the year ending June 2007 and thereafter accelerate to around 3.5 pct through 2008 as a result of an expected strengthening in the housing cycle. "These forecasts for domestic demand imply that employment growth will slow to around 1.50-1.75 pct by mid 2007 per annum, which means that there is now little further headway expected in lowering the unemployment rate," Oster said. On the inflation outlook, the NAB economist said slower productivity growth together with higher indirect effects from high oil prices and little slowing in wage demands should lead core inflation higher over the next six months to peak at the end of this year at 3.25 pct. "There is little the RBA can do about that prospect. Recent policy tightening will, however, see core inflation moving back into the RBA's target range by mid 2007," Oster said. The RBA targets a headline rate in the 2-3 pct range on average over an economic cycle. Oster said if the RBA is to increase cash rates further in 2006, it will be at the November board meeting following the release of the September quarter consumer inflation data due on Oct 25. "Our judgment is that the chances an additional tightening are currently around 25 pct. That is, we are increasingly confident that our activity forecasts are on target and that the RBA will look through the short-term inflation breaches," he said. The chief economist noted the RBA will be aware any over aggressive monetary tightening could well trigger serious issues in the larger states and lead to interest rate cuts during 2007.